Investors in Sydney could expect healthier returns on their properties as the city's rental market tightens further.

The latest data from the Real Estate Institute of NSW (REINSW) showed that vacancy rates in all parts of the city dropped to 0.9% in February. This is the first time all of Sydney - from the inner to outer suburbs - has experienced less than 1% vacant rental properties.

The dire rental situation is also evident in regional areas, with the university towns of Newcastle and Wollongong both recording significant falls. Vacancy rates in Newcastle dropped to 1% from 1.6% in January, while Wollongong fell to 1.5% from 2.2%.

An earlier report from Residex showed the median rent for an average Sydney house in January is $450 - a 25% jump from a year ago. Units fetched $385 per week, which is 22.22% higher compared to 12 months ago. A rental house in Sydney achieved 4.01% yield, while units achieved 5.01%.

With the RBA lifting rates by 0.25% twice this year and major banks adding around 0.15% to the mortgage rate, investors will need to raise rents further to cover the 0.65% increase in mortgage rates. A Westpac report said that to cover the higher cost, yields will need to rise to 5.4% by the end of 2008, with no increase in price/debt. "A 10% increase in rents will achieve this growth," it said.

The report noted that the rising cost of finance and low vacancy rates will allow landlords to lift rents by the required 10% to follow the rise in repayments.

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